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Southwest Airlines CEO Flies Uncharted Skies

By

Mike Esterl

Updated March 25, 2009 12:01 a.m. ET

DALLAS -- Gary Kelly is navigating
Southwest Airlines Co.
LUV 0.43%
through one of the industry's most turbulent periods by expanding into new markets and tinkering with the carrier's low-cost service.

But Mr. Kelly says adding full-scale meals remains off the table. And Southwest, the largest U.S. discount carrier by revenue, remains steadfast against charging customers for checking in suitcases and using pillows, as rivals have done.

"Adding fees is not the way to grow the airline," Mr. Kelly says in an interview at the company's headquarters here. "Customers hate that stuff."

Last week, true to discount roots dating to 1971, Southwest launched a summer fare sale on domestic flights, with one-way prices as low as $49. As in the past, major competitors were forced to follow suit.

By keeping costs low with simple operations, Southwest has booked 36 straight years of profit and flies more passengers within the U.S. than anyone else. Southwest is the only major U.S. airline to enjoy an investment-grade credit rating.

But the company hasn't been immune to the broader downturn in the airline industry as cash-strapped consumers and corporations pare travel. After logging a 12% increase in revenue last year, Southwest's passenger traffic in January and February fell 10% from a year earlier. The company's shares have declined since last year. But shares at its major rivals have dropped more sharply amid a collapse in international and premium traffic.

The International Air Transport Association projected Tuesday that industry revenue will fall 12% globally to $467 billion this year, pushing industry losses to $4.7 billion. Southwest posted losses in the third and fourth quarters after hedging contracts on fuel prices backfired.

The strains are forcing the 54-year-old Mr. Kelly, a two-decade veteran at Southwest who became CEO in 2004, to cast a wider net for business. "There are opportunities to tap that we haven't taken advantage of," says Mr. Kelly, who became Southwest's chairman last year, succeeding co-founder Herb Kelleher.

Mr. Kelly says Southwest will stick with point-to-point flights instead of the hub-and-spoke system used by other major airlines. It also will continue flying a single airplane model, the Boeing 737, to keep maintenance and training uncomplicated.

But he has begun redeploying Southwest's fleet of more than 500 airplanes, eliminating unpopular late-night and early-morning flights on some routes so he can target new markets. This month the airline began flying to Minneapolis, its 65th U.S. city. Flights are planned for later this year to New York's LaGuardia and Boston's Logan airports, highly competitive destinations Southwest had long avoided in favor of smaller locations.

Mr. Kelly also says he's interested in code-sharing deals with foreign carriers in Europe and Asia -- markets that other major U.S. airlines already have entered aggressively -- to expand Southwest's footprint beyond North America. He declines to say if the airline is in talks with potential overseas partners. A code-sharing agreement with Canada's
WestJet Airlines Ltd.
WJAFF -4.84%
will take flight this year, and an alliance with Mexico's Volaris D.F. is expected to start next year.

Straying slightly from Southwest's stripped-down strategy, satellite-based WiFi Internet access is being tested on four planes. Mr. Kelly plans to decide on a broader rollout in the coming weeks.

Southwest also is planning to ratchet up its wine and coffee offerings even as it continues to steer clear of serving meals. Alcoholic beverages aboard Southwest currently cost $4, below the industry norm, but Mr. Kelly says coffee will stay free.

Not everyone is convinced Southwest is doing enough to ensure robust growth when the economy rebounds. Some analysts question if management has made the right call by not charging for formerly free services, which are generating hundreds of millions of dollars in annual revenue for rivals.

"When everyone else is collecting significant sums off the table and Southwest is just leaving it there, you have to wonder how much longer that can go on," says Robert Mann, an airline-industry consultant in Port Washington, N.Y.

Other analysts say Southwest's cost advantages over other big carriers are shrinking. Many rivals went through bankruptcy proceedings in recent years, allowing them to tear up labor contracts and negotiate lower pay packages. Wages have continued to rise at Southwest, which has a policy of not laying off workers during downturns.

There is "not a lot of low-lying fruit" at Southwest, says Hunter Keay, an airline analyst in Baltimore at Stifel Nicolaus Capital Markets.

But Mr. Kelly says furloughs remain a last resort and that high morale among employees translates into more productivity and better customer service. Many cubicles in Dallas last week were still decorated with pink balloons from a Valentine's Day celebration. And on St. Patrick's Day, office staff wore green and munched green M&M's. "It's a people-intensive business," Mr. Kelly says.